Archive for March, 2014
Some time ago we looked at the rare phenomenon that is the consumer confidence indicator:
It has been observed that making decisions on the basis of economic releases is like driving your car while looking only in the rear view mirror. The “latest” data, as a rule, only tells you what happened in the past: that GDP number refers to last quarter, those unemployment figures are the fruit of hiring decisions taken possibly years ago, and even that inflation number only tells you what prices did last month.
As with any rule, however, there is an exception. Confidence surveys can give a reliable indication of future economic out-turns as they poll people about their intentions, and private consumption is invariably the largest component of economic output.
This week, consumer confidence data was published for the US, the UK and the Eurozone. In each case confidence both rose on the month and exceeded economists’ expectations.
Conference Board data for the USA rose to a six-year high. In Euroland the indicator reached its highest level since November 2007, punching above the twenty year average for the measure in the process. And in the UK, GfK data showed the mood of the British consumer improving to its strongest pitch since August 2007.
At the more granular level in Europe in particular the signs have been encouraging. We dealt recently with the risk posed to the eurozone by possible weakness in France; well, French consumer confidence data posted the strongest result this week since July 2012. In Italy too, we had the best result for this indicator since the year before that. Both of these outcomes were positive surprises for the market.
Elsewhere in the world the news is not so unequivocally positive. In Japan for instance, the sales tax goes up on Tuesday from 5% to 8% – a well-flagged move but one which has had a measurable impact on confidence and consumer behaviour. Then again, one might equally point to the positive surprise in the US, which suggests that the growth impact of the coldest winter since 2009-10 / 1911-12 (depending on the measurement period) will prove more transient than some had expected.
This week’s releases are good news. This blog highlighted going into the New Year that growth would be a crucial topic for 2014. Political risk and anxiety over the Chinese peril certainly do not help. But these confidence indicators suggest that developed-world growth, which has only just begun growing over consecutive quarters for the first time since 2010, will continue to improve from here. That would certainly help bring us closer to the end of the beginning of the protracted torture of the financial crisis .. And, of course, closer to a new set of problems in due course.
China. My goodness but we’re all worried about her at the moment!
There was another splash on the FT this morning about warnings of hard times ahead for some private investors as bond and trust investment defaults are expected to increase (further from zero) in coming months. And of course there has also been much attention given to the Chinese property market, which may be in a bubble; which may be primed to burst.
All this sounds rather worrying. Before commenting further there are three facts we need to observe:
- China approaches any potential bear period in the default cycle from a strong position. The required deposit reserve ratio for major banks stands at 20%, headline real GDP growth of 7.5% per year counts as a recession and managing the strengthening of renminbi in a stately fashion has built up foreign currency reserves of $3.8trn (comfortably more than twice total gross government debt as forecast by the IMF for 2013 – which itself stands at an unterrifying 23% of GDP).
- Commentators cried wolf on the property market ages ago. Two years back – a very bearish time, let us remember – there was a lot of talk abroad about the imminent collapse of Chinese real estate. In fact, even before then (worried about something called “inflation”), the Chinese had been tightening monetary policy via interest rates, exchange rates, and that bank reserve ratio in a deliberate attempt to slow the economy which had already seen the country’s real estate climate indicator fall sharply (it remains well below its ten-year average today).
- Chinese reported EPS, as measured by the CSI 300 Index, have grown faster than earnings for the S&P 500 since the nadir of 2008, grew faster in 2013 and are forecast to grow faster this year too. This is a good reflection of relative rates of growth in GDP. The difference in price behaviour has resulted in a US valuation multiple of 17x, well off the 2009 low and above the ten-year average; and a Chinese earnings multiple of under 10x, well below the ten-year average and lower even than the previous nadir reached in the middle of the Great Recession.
So it seems very unlikely, to say the least, that trust and real estate worries in China will lead to anything like the effects of (say) the subprime mortgage debacle on the US, or if they do, that this is not already priced in.
That is not to discount the possibility of distress entirely of course. The boy who cried wolf, morals about honesty aside, was proved right in the end.
So let us turn to China’s undeniable problem: it is a deeply unfree country. Looking at the World Bank indicators on national governance, China ranks broadly in line with other EM economies such as India and Brazil on measures such as the efficacy of government, the rule of law and the control of corruption. But in terms of popular voice and government accountability she is among the worst in the world. Coming in at the 5th percentile China is less free than Iran, Belarus or the Congo, and significantly less so than Russia (which does appallingly on the other measures by comparison).
This means very limited freedom on investment opportunities for the Chinese (generating disproportionate interest in real estate, for instance, and complex trust structures), coupled with controls on capital movements and profit repatriation with which Western investors are very familiar.
In itself this lends only a limited amount of credence to the idea that the big, bad wolf stands at China’s door. It remains much easier to see Western economies being bankrupted by their banking systems. But for anyone looking for the structural problem with the Chinese economy: that is it.
As a final aside, we should also remember how those trillions in imported reserve dollars are invested. China is the biggest foreign holder of US government debt in the world, and towards the end of last year sold nearly $50bn worth (out of a $1.3trn total). That’s five times the amount of monthly “tapering” being undertaken by the Fed.
In other words, if the bears are right about China being on the brink of some kind of systemic collapse, it is utterly impossible for the world to remain immune; not least the Treasury market, which has had a nice rally this year so far. The decoupling of emerging market and developed-world performance has been an eye-catching feature of recent quarters, but – one way or another – it is not really sustainable.
An enormous amount has been written about the current situation in Ukraine and one intention of this post is not to duplicate overmuch. The politics has mostly been well covered elsewhere for instance. The economic discussion, however, has tended to focus on its direct effects, such as trade sanctions, commodity prices, and Russian asset and currency weakness. But there is an indirect effect at work that could have important economic and market consequences over the medium and long term; consequences which would have seemed very surprising only a short time ago.
The maps displayed on news websites over the last couple of weeks have tended to focus on Ukraine itself – colour-coded from time to time by language or broad ethnicity – and more latterly on the Crimea. Events further north have received less attention, yet there has been some real anxiety and sabre-rattling in the Baltic too.
On Monday, Russian forces conducted exercises in the Kaliningrad exclave on the Polish and Lithuanian borders:
Defense Minister Sergei Shoigu earlier said the snap inspections of more than 150,000 troops of western and northern military units were not connected with events in Ukraine.
Perish the thought. On the same day, a website in Poland published photographs of troop movements observed by members of the public, connecting them speculatively with events over the border with Ukraine:
Poland’s defence minister … told the TVN24 news station that “there are no movements of Polish troops which deviate from their usual routine” and that any movement[s] of soldiers and equipment are due to “routine exercises”.
Naturally. Then yesterday, it was announced that American fighters and service personnel are to be dispatched to Poland, and also that fighters and tanker planes had arrived in Lithuania to reinforce air patrols over the Baltic states. This time the connection with Ukraine was explicit. Both Poland and Lithuania are members of NATO.
This brings us on to the economic point: neither Poland nor Lithuania are yet members of the euro. Estonia joined in 2011, Latvia has just joined this year and Lithuania is set to join in 2015. Poland, however – observing the sovereign debt crisis and benefiting from currency depreciation on occasion – has been lukewarm on the matter and is not yet even in the ERM. But this week, governor of the National Bank of Poland Marek Belka said that security concerns should change the country’s thinking:
Belka said the standoff in Ukraine is increasing the political benefits of becoming part of the euro area and its $12 trillion economy, which would give Poland a seat among the “core group” of EU countries …
“There’s more influence” inside the euro area on issues ranging from defense to energy policies, Belka told reporters this week. “Even if the economic benefits today look modest, we need to make the political calculation as well.”
The euro area “is an island of stability” that “certainly looks attractive” to countries that feel threatened by the situation in Ukraine, Mario Draghi, the president of the European Central Bank, told reporters in Frankfurt yesterday, when asked about Belka’s comments.
This kind of thinking, coming from the biggest economy in the eastern part of the EU bloc, could carry over to other EU members who remain wedded to the euro only in theory. Bulgaria and Romania, for instance, have put back firm plans for joining in the past. Might these be brought forward again? The Czech Republic made weaker commitments after joining the EU in 2004 but these fizzled out; again, it may be possible for the tide there to turn. Various weaknesses have emerged as stumbling blocks to Croatia and Hungary, though European recovery should help overcome them.
On the other hand, Sweden has no plans to join and is unlikely to be subject to the same pitch of political concerns over current events in the east; and Britain and Denmark remain opted out of the project.
The policial point raised about membership by Mr Belka is of course a valid one. During a chequered visit to the UK recently, EU Commission Vice-President Viviane Reding stated her belief that “the eurozone should become the United States of Europe.” And in connection with Ukraine, Commission President Barroso – in addition to his commitment to supporting the country with €11bn of aid – said only yesterday:
Not only we have reiterated the European Union’s commitment to signing the Association Agreement … we have also decided, as a matter of priority, that we will sign very shortly the political chapters. This means notably the general principles, the part on political cooperation and the Common Foreign and Security Policy (CFSP) of the Association Agreement. This will seal the political association of the European Union and Ukraine.
This might not mean too much in practice. After all, how many divisions has the EU Commission? And there are several countries – including Finland, who has a peaceful shared border with Russia – which are signed up to the EU and the euro and are not members of NATO. Still, one can see why some in Poland and elsewhere might be encouraged by this kind of thing, and Vladimir Putin and others rather less enthralled.
To summarise: negative sentiment on euro membership arising from the sovereign debt crisis has abated with the crisis itself. Further, it is clear that an unwitting consequence of the new crisis in Ukraine has been to make membership seem more attractive, at least to some.
Over the medium term this could entail market convergence as seen in the late 1990s: the extra yield on ten year local currency debt issued by Poland compared to euro-denominated debt is 1.5%, for example, and this gap would be expected to close.
Over the longer term, as the eurozone in particular gains momentum in its quest for “ever closer union”, the position of the dwindling number of EU states outside it would look increasingly anomalous. The economic consequences of political change taking place as a result of this, especially here in Britain, are unpredictable.